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CHAPTER 4
THE INTERNAL ASSESSMENT
CHAPTER OUTLINE
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The Nature of an Internal Audit
The Resource-Based View
Integrating Strategy and Culture
Management
Marketing
Finance/Accounting
Production/Operations
Research and Development
Management Information Systems
Value Chain Analysis
The Internal Factor Evaluation (IFE) Matrix
CHAPTER OBJECTIVES
After studying this chapter, you should be able to do the following:
1.
2.
3.
4.
5.
Describe how to perform an internal strategic-management audit.
Discuss the Resource-Based View (RBV) in strategic management.
Discuss key interrelationships among the functional areas of business.
Compare and contrast culture in the United States versus other countries.
Identify the basic functions or activities that make up management, marketing, finance/
accounting, production/operations, research and development, and management information
systems.
6.
Explain how to determine and prioritize a firm’s internal strengths and weaknesses.
7.
Explain the importance of financial ratio analysis.
8.
Discuss the nature and role of management information systems in strategic management.
9.
Develop an IFE Matrix.
10. Explain benchmarking as a strategic management tool.
I. THE NATURE OF AN INTERNAL AUDIT
A. Strengths and Weaknesses
1. All organizations have strengths and weaknesses in the functional areas of business.
No enterprise is equally strong or weak in all areas. Internal strengths/weaknesses,
coupled with external opportunities/threats and a clear statement of mission, provide
the basis for establishing objectives and strategies.
2. The internal-audit part of the strategic-management process is illustrated in Figure 4-1.
B. Key Internal Forces
1. A firm’s strengths that cannot be easily matched or imitated by competitors are called
distinctive competencies. Building competitive advantages involves taking advantage
of distinctive competencies.
2. Strategies are designed in part to improve on a firm’s weaknesses, turning them into
strengths, and maybe even into distinctive competencies.
C. The Process of Performing an Internal Audit
1. The process of performing an internal audit closely parallels the process of performing
an external audit. Representative managers and employees from throughout the firm
need to be involved in determining a firm’s strengths and weaknesses.
2. Performing an internal audit requires gathering, assimilating, and evaluating
information about the firm’s operations.
3. Compared to the external audit, the process of performing an internal audit provides
more opportunity for participants to understand how their jobs, departments, and
divisions fit into the whole organization.
4. Financial ratio analysis exemplifies the complexity of relationships among the
functional areas of business.
II.
THE RESOURCE-BASED VIEW (RBV)
A. Internal Factors versus External Factors
1. The RBV takes the opposing view to that of the I/O theorists discussed in Chapter 3.
The RBV approach to competitive advantage contends that internal resources are
more important than external factors for a firm in achieving and sustaining
competitive advantage.
2. Internal resources come from three categories.
a. Physical resources: plant, equipment, location, technology, raw materials, machines,
etc.
b. Human resources: employees, training, experience, intelligence, knowledge, skills,
abilities, etc.
c. Organizational resources: firm structure, planning processes, information systems,
patents, trademarks, copyrights, databases, etc.
B. The Basic Premise
1. The mix, type, amount, and nature of a firm’s internal resources should be considered
first and foremost in devising strategies that can lead to sustainable competitive
advantage.
2. Firms should pursue strategies that are not currently being implemented by any
competing firm.
C. Valuable Resources
1. Resources are only valuable if they have one or more of the following characteristics:
a. rare
b. hard to imitate
c. not easily substitutable
III.
INTEGRATING STRATEGY AND CULTURE
A. Strategy and Culture
1. Relationships among a firm’s functional business activities perhaps can be
exemplified by focusing on organizational culture, an internal phenomenon that
permeates through all departments and divisions of an organization.
2. Organizational culture can be defined as a pattern of behavior developed by an
organization as it learns to cope with its problem of external adaptation and internal
integration that has worked well enough to be considered valid and to be taught to new
members as the correct way to perceive, think, and feel. Remarkably resistant to
change, culture can represent a major strength or weakness for the firm.
3. Defined in Table 4-1, cultural products include values, beliefs, rites, rituals,
ceremonies, myths, stories, legends, sagas, language, metaphors, symbols, heroes, and
heroines.
4. Organizational culture significantly affects business decisions and thus, must be
evaluated during an internal strategic-management audit.
B. United States versus Foreign Cultures
1. To successfully compete in world markets, U.S. managers must obtain a better
knowledge of historical, cultural, and religious forces that motivate and drive people in
other countries.
a. In Japan, for example, business relations operate within the context of wa, which
stresses group harmony and social cohesion. In China, business behavior revolves
around guianxi, or personal relations. In Korea, activities involve concern for
inhwa, or harmony based on respect of hierarchical relationships, including
obedience to authority.
b. U.S. managers have a low tolerance for silence, whereas Asian managers view
extended periods of silence as important for organizing and evaluating one’s
thoughts. The book lists other important differences between U.S. and foreign
managers.
2. Table 4-2 contains an excellent list of cultural pitfalls that individuals need to know
when traveling in foreign countries.
3. Probably the biggest obstacle to the effectiveness of U.S. managers, or managers from
any country working in another, is the fact that it is almost impossible to change the
attitude of a foreign workplace. “The system drives you; you cannot fight the system
or culture,” says Bill Parker, president of Phillips Petroleum in Norway.
IV.
MANAGEMENT
A. The Functions of Management
1. The functions of management consist of five basic activities: planning, organizing,
motivating, staffing, and controlling. An overview of these activities is provided in
Table 4-3.
a. Planning—Planning consists of all those managerial activities related to preparing
for the future. Specific tasks include forecasting, establishing objectives, devising
strategies, developing policies, and setting goals. Planning is most important in the
strategy-formulation stage of the strategic-management process.
b. Organizing—Organizing includes all those managerial activities that result in a
structure of task and authority relationships. Specific areas include organizational
design; job specialization, descriptions, specifications, design, and analysis; span
of the control; unity of command; and coordination. Organizing is most important
in the strategy implementation stage of the strategic-management process.
c. Motivating—Motivating involves efforts directed toward shaping human
behavior. Specific topics include leadership, communication, work groups,
behavior modification, delegation of authority, job enrichment, and so on.
Motivating is most important in the strategy-implementation stage of the strategicmanagement process.
d. Staffing—Staffing activities are centered on personnel or human resource
management. Included are wage and salary administration, employee benefits,
interviewing, hiring, firing, training, employee safety, and so on. Staffing is most
important in the strategy-implementation stage of the strategic-management
process.
e. Controlling—Controlling refers to all those managerial activities directed toward
ensuring that actual results are consistent with planned results. Key areas of
concern include quality, financial, sales, inventory, and expense control; analysis
of variances; rewards; and sanctions. Controlling is most important in the strategyevaluation stage of the strategic-management process. It consists of four basic
steps: 1) establishing performance standards, 2) measuring individual and
organizational performance, 3) comparing actual performance to planned
performance standards, and 4) taking corrective actions.
V.
MARKETING
A. Marketing
1. Marketing. Marketing can be described as the process of defining, anticipating,
creating, and fulfilling customers’ needs and wants for products and services. There
are seven basic functions of marketing: (1) customer analysis, (2) selling
products/services, (3) product and service planning, (4) pricing, (5) distribution, (6)
marketing research, and (7) opportunity analysis.
2. Customer Analysis. Customer analysis—the examination and evaluation of consumer
needs, desires, and wants—involves administering customer surveys, analyzing
consumer information, evaluating market positioning strategies, developing customer
profiles, and determining optimal market segmentation strategies.
a. The information generated by customer analysis can be essential in developing an
effective mission statement.
b. Successful organizations continually monitor present and potential customers’
buying patterns
3. Selling Products/Services. Successful strategy implementation generally rests on the
ability of an organization to sell some product or service. Selling includes many
marketing activities such as advertising, sales promotion, publicity, and so on. Table
4.4 lists the firms which spend the most on advertising.
4. Product and Service Planning. Product and service planning include activities such as
test marketing; product and brand positioning; devising warranties; packaging;
determining product options, product features, product style, and product quality;
deleting old products; and providing for customer service.
a. One of the most effective product and service planning techniques is test
marketing.
b. Consumer goods companies use test marketing more frequently than industrial
goods companies. It can allow companies to avoid substantial losses by revealing
weak products and ineffective marketing approaches before large-scale production
begins.
5. Pricing. Five major stakeholders affect pricing decisions: consumers, governments,
suppliers, distributors, and competitors.
a. Sometimes an organization will pursue a forward integration strategy primarily to
gain better control over prices charged to consumers.
b. Governments can impose constraints on price fixing, price discrimination,
minimum prices, unit pricing, price advertising, and price controls.
6. Distribution. Distribution includes warehousing, distribution channels and coverage,
retail site locations, sales territories, inventory levels and location, transportation
carriers, wholesaling, and retailing.
a. Distribution becomes especially important when a firm is striving to implement a
market development or forward integration strategy.
b. Successful organizations identify and evaluate alternative ways to reach their
ultimate market.
7. Marketing Research. Marketing research is the systematic gathering, recording, and
analyzing of data about problems relating to the marketing of goods and services.
a. Marketing research can uncover critical strengths and weaknesses, and marketing
researchers can employ numerous scales, instruments, procedures, concepts, and
techniques to gather information.
b. Marketing research activities support all major business functions.
8. Opportunity Analysis. The next function of marketing is opportunity analysis, which
involves assessing the costs, benefits, and risks associated with marketing decisions.
a. Three steps are required to perform a cost/benefit analysis: (1) compute the total
costs associated with a decision, (2) estimate the total benefits from the decision,
and (3) compare the total costs with the total benefits.
b. As expected benefits exceed total costs, an opportunity becomes more attractive.
VI.
FINANCE/ACCOUNTING
A. Importance of Finance and Accounting
1. Financial condition is often considered the single best measure of a firm’s competitive
position and overall attractiveness to investors. Determining an organization’s
financial strengths and weaknesses is essential to formulating strategies effectively.
2. A firm’s liquidity, leverage, working capital, profitability, asset utilization, cash flow,
and equity can eliminate some strategies as being feasible alternatives.
B. Finance/Accounting Functions
1. According to James Van Horne, the functions of finance/accounting comprise three
decisions: the investment decision, the financing decision, and the dividend decision.
2.
Basic Types of Financial Ratios. Financial ratios are computed from an organization’s income
statement and balance sheet. Trend analysis, illustrated in Figure 4-2, is an example of a technique that
incorporates both the time and industry average
3. Key Financial Ratios—Table 4-5 lists good websites for getting financial information.
Table 4-6 provides a summary of key financial ratios showing how each ratio is
calculated and what each ratio measures. They can be classified into five types.
a. Liquidity ratios measure a firm’s ability to meet maturing short-term obligations.
1. Current ratio
2. Quick (acid-test) ratio
b. Leverage ratios measure the extent to which a firm has been financed by debt.
1. Debt-to-total assets ratio
2. Debt-to-equity ratio
3. Long-term debt-to-equity ratio
4. Times-interest-earned (coverage) ratio
c. Activity ratios measure how effectively a firm is using its resources.
1. Inventory turnover
2. Fixed assets turnover
3. Total assets turnover
4. Accounts receivable turnover
5. Average collection period
d. Profitability ratios measure a management’s overall effectiveness as shown by
returns generated on sales and investment.
1. Gross profit margin
2. Operating profit margin
3. Net profit margin
4. Return on total assets
5. Return on stockholders’ equity
6. Earnings per share
7. Price-earnings ratio
e. Growth ratios measure the firm’s ability to maintain its economic position in the
growth of the economy and industry.
1. Sales
2. Net income
3. Earnings per share
4. Dividends per share
B. Additional Components of Financial Ratio Analysis
1. How has each ratio changed over time?
2. How does each ratio compare to industry norms?
3. How does each ratio compare with key competitors?
VII. PRODUCTION/OPERATIONS
A. Production and Operations
1. The production/operations functions of a business consist of all those activities that
transform inputs into goods and services.
2. Production/operations management deals with inputs, transformations, and outputs
that vary across industries and markets.
3. The production/operations activities often represent the largest part of an
organization’s human and capital assets.
4. Table 4-7 illustrates the basic functions of production operations management,
including process, capacity, inventory, workforce, and quality. Table 4-8 provides the
impact of strategy elements on production management.
VIII.
RESEARCH AND DEVELOPMENT (R&D)
A. Importance of R&D
1. The fifth major area of internal operations that should be examined for specific
strengths and weaknesses is R&D. Many firms today do not conduct R&D, and yet
many other companies depend on successful R&D activities for survival. Firms
pursuing a product development strategy especially need to have a strong R&D
orientation.
B. Internal and External R&D
1. R&D in organizations can take two basic forms: (1) internal R&D, in which an
organization operates its own R&D department, and/or (2) contract R&D, in which a
firm hires independent researchers or independent agencies to develop specific
products. Many companies use both approaches to develop new products. A widely
used approach for obtaining outside R&D assistance is to pursue a joint venture with
another firm.
IX.
2. Most firms have no choice but to continually develop new and improved products
because of changing consumer needs and tastes, new technologies, shortened product
life cycles, and increased domestic and foreign competition.
MANAGEMENT INFORMATION SYSTEMS
A. Importance of Information
1. Information ties all business functions together and provides the basis for all
managerial decisions.
2. A management information system receives raw material from both the external and
internal evaluation of an organization. It gathers data about marketing, finance,
production, and personnel matters internally; and social, cultural, demographic,
environmental, economic, political, government, legal, technological, and competitive
factors externally. Data is integrated in ways needed to support managerial decision
making.
3. Because organizations are becoming more complex, decentralized, and globally
dispersed, the function of information systems is growing in importance.
B. Strategic Planning Software
1. Strategic planning software can allow firms to tap the knowledge base of everyone in
the firm. There are a number of commercially available software products designed to
train and assist managers in strategic planning.
X.
VALUE CHAIN ANALYSIS
A. Porter describes the business of a firm as a value chain, in which total revenues minus total costs
of all activities undertaken to develop and market a product or service yields value.
B. Value Chain Analysis refers to the process whereby a firm determines the costs associated
with organizational activities from purchasing raw materials to manufacturing products to
marketing those products. An example is provided in Figure 4-3.
C. All firms should use value-chain analysis to develop a nurture a core competence and
develop this competence into a distinctive competence.
1. A core competence is a value-chain activity that a firm performs especially well.
2. When a core competence evolves into a major competitive advantage, it is called a
distinctive competence. Figure 4-4 illustrates this process.
D. Firms use benchmarking to determine whether its value chain activities are competitive
compared to rivals. This entails measuring the costs of value chain activities across an
industry to determine “best practices” among competing firms for the purpose of
duplicating or improving upon those best practices.
XI.
THE INTERNAL FACTOR EVALUATION (IFE) MATRIX
A. The IFE Matrix
1. A summary step in conducting an internal strategic-management audit is to construct
an IFE Matrix. This strategy-formulation tool summarizes and evaluates the major
strengths and weaknesses in the functional areas of a business, and it also provides a
basis for identifying and evaluating relationships among these areas.
2. Intuitive judgments are required in developing an IFE Matrix, so the appearance of a
scientific approach should not be interpreted to mean this is an all-powerful technique.
B. An IFE Matrix is developed in five steps. An example IFE Matrix is provided in Table 49.
1. List key internal factors as identified in the internal-audit process. Use a total from ten
to twenty internal factors including both strengths and weaknesses.
2. Assign a weight ranging from 0 (not important) to 1.0 (very important). The weight
indicates the relative importance of the factor to being successful in the firm’s
industry. The sum of all the weights must equal 1.0.
3. Assign a 1-4 rating to each factor to indicate whether that factor represents a major
weakness (1), minor weakness (2), minor strength (3), or major strength (4).
4. Multiply each factor’s weight by its rating to determine a weighted score for each
variable.
5. Sum the weighted scores for each variable to determine the total weighted score for
the organization.
6. Total weighted scores of below 2.5 indicate an internally weak organization.